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 Post subject: Student Loan Interest vs. Principal
PostPosted: Sun Nov 04, 2012 9:35 pm 
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Joined: Sun Jul 15, 2007 7:54 pm
Posts: 27
Location: Phoenix, AZ
Hi,

It's been about two years since I've been here. I had just taken out a 0% loan on a new car after my old one was totaled in a hail storm, and wasn't feeling too pleased with myself. About six month after that (June 2011), I was laid off from my job. I wasn't really broken up about losing my job because it was with an awful company whose purpose and product I did not agree with. Also, just before my layoff I had realized that the career change I was in search of was in accounting (previous degree in business/marketing), so it was an opportunity for me to return to school to pursue this goal.

That said, I chose to pay for school with student loans. My previous degree left me with no debt, but now I'm like so many others with these loans hanging over my head. I'll be finished with my Master of Accountancy degree in May '13, and should be able to work and pay off the loans pretty quickly.

Now for my question. Student loan interest paid during the year up to $2,500 can be claimed as a credit on federal income taxes. During the last year I received a settlement from a class-action suit against a former employer. This leaves me with enough income during 2012 when combined with my internship earnings that I can make some kind of payment (and I will likely owe more than the payment amount in taxes, as well). I am currently leaning toward making payments toward all the interest that has accrued (~$1,900) this year because it would come back to me in the form of a tax credit and reduce what I owe come April 15. But when I was looking at making a payment online today, one loan offered the ability to take the payment directly off the principal as a "return." While this would reduce the amount of interest owed over the life of the loan, it would have no effect on what I owe in income taxes this year. I am leaning toward paying the accrued interest because the funds would be coming out of what I have set aside for my income tax payment. If I paid on principle, I would still have the same tax liability and would have to pay that regardless, and I don't think I'll have enough to make a double payment to both principle and interest. Does what I'm thinking about doing seem to make sense?

Thanks.

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Car loan of approx. 5k at 0%.
Student loans of approx 60k that are going to be taken out quickly. Wedding comes first.


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 Post subject: Re: Student Loan Interest vs. Principal
PostPosted: Mon Nov 05, 2012 5:41 am 

Joined: Tue Mar 11, 2008 12:19 pm
Posts: 1716
Location: Ottawa, Canada
As far as I know, what you're describing isn't possible. I don't believe you can make a payment and specify that it's to be applied only to the interest. As I understand it, you just make a payment, and that's it.

For the purposes of taxes, I would expect you can deduct your student loan interest regardless of how much you paid toward it that year. If your loan accrued $2,000 in interest (regardless of how many payments you made, or whether you made any at all), then you deduct that interest from your income.

I'm not an expert, but that's always how I understood it to work.


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 Post subject: Re: Student Loan Interest vs. Principal
PostPosted: Mon Nov 05, 2012 5:54 am 
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You will need to call the company. This is certainly unusual and, as kombat said, may not be possible. But your reasons make perfect sense. They might have a way to do it.

But the other thing is, it may not be necessary. You have paid the interest during the year. It has accrued to the loan. It does not matter if you actually make a cash payment I don't think. This is something you should research yourself - you are an accountant after all.


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 Post subject: Re: Student Loan Interest vs. Principal
PostPosted: Mon Nov 05, 2012 6:40 am 

Joined: Wed Oct 24, 2012 8:27 am
Posts: 3
Location: Houston, TX
When I was still in school, I got a statment every few months that offered the option of making a payment towards the interest. The loans are deferred, so no payments are due, but they are accruing interest. I personally paid towards interest when I could, but it wasn't often. It never occured to me to pay towards priciple though, so I can't really say which would be a better option.

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 Post subject: Re: Student Loan Interest vs. Principal
PostPosted: Mon Nov 05, 2012 8:33 am 

Joined: Fri May 04, 2012 2:23 pm
Posts: 810
If a unsubsidized student loan (aka, the juice is runnin')...Interest accrues daily without it becoming capitalized. E.g. $10k loan @ 5% = $1.37/day in interest. You accrue this while you are in school, each and every day. Specified events trigger when this becomes capitalized (added to the principal). These events usually are a certain number of months after you drop out or graduate. It is wise to clear as much interest as possible before you go into payment mode. If you make a payment while in school, if allowed, you must clear all interest before you can start to eat away at the principal. It is wise to ALWAYS reduce your principal if you can. The "interest only" option only benefits the lender.

Did you secure this loan through a financial aid office? If so, I would recommend making an appointment with your counselor and discussing the specific terms of your loan with them and the ramifications of your future courses of action. They can be much more helpful than we are since they will be privy to the specific terms. If something doesn't smell right, come and ask us. If they aren't being helpful, tell them (politely). Perhaps there is someone else you can ask. If they're being a jerk, talk to their boss. Fin Aid counselors are there to help you. Not the other way around.

Also, while I would never suggest anyone to break a law, you may want to tell the fin aid counselor that you are just curious how the loan works. A windfall may mean they end up adjusting your FAFSA (and it will show for next year if you're reporting on your taxes). If this is a private loan and that is all you get, they most likely won't care. But I wouldn't walk into the office with "benjamins" falling out of my pocket and asking aid to pay for school.

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"If you only have 1 year to live, move to Penn...as it will seem like an eternity."


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 Post subject: Re: Student Loan Interest vs. Principal
PostPosted: Mon Nov 05, 2012 8:18 pm 
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Joined: Sun Jul 15, 2007 7:54 pm
Posts: 27
Location: Phoenix, AZ
I guess I should have said why I can repay part of the principal on the loan. It's because it (or a large part of it) was disbursed in the last 120 days (the beginning of the current semester). I wouldn't even have known that was possible if the loan servicer hadn't advised me of that. I'm specifically interested in getting input on the decision of the payment on principle and a potentially higher tax bill versus paying only interest and taking the deduction without reducing principle. It seems like paying the interest down this year would get me the best result by being a reduction in overall debt and a reduction in my tax liability.

If this "return" option wasn't there, it would go to cover all interest before touching the principle. It's just a wrinkle that was thrown in there that is throwing me off.

_________________
Car loan of approx. 5k at 0%.
Student loans of approx 60k that are going to be taken out quickly. Wedding comes first.


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 Post subject: Re: Student Loan Interest vs. Principal
PostPosted: Tue Nov 06, 2012 12:58 pm 

Joined: Fri Sep 12, 2008 12:29 pm
Posts: 1592
Location: Seattle, WA
It's true that in almost all situations, payments are applied to interest first and then principal. It doesn't really matter anyways, because the interest is capitalized (meaning, interest is charged on the interest) at the same interest rate as the principal, so it's six of one half a dozen of the other - either way the balance ends up the same.

This is a unique situation for two reasons, as I understand it:
1) The interest is not capitalized. So the interest does not earn more interest.
2) You can return some of the money, meaning it will be as if you never accepted the that part of loan money in the first place.

I am not clear on what the rules are on when you can deduct uncapitalized student loan interest while still a student. If you need to make a payment, and not just a return of funds, then can you just wait until the 120 days expire before doing so?


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 Post subject: Re: Student Loan Interest vs. Principal
PostPosted: Tue Nov 06, 2012 4:34 pm 
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stannius wrote:
It's true that in almost all situations, payments are applied to interest first and then principal. It doesn't really matter anyways, because the interest is capitalized (meaning, interest is charged on the interest) at the same interest rate as the principal, so it's six of one half a dozen of the other - either way the balance ends up the same.


That is generally true. But the exact dates when interest accrues can make a big difference on certain type of loans. On your mortgage for example there are some loans that apply interest on the 1st of a month, some on the last day, and still others that apply it based on a 30 day month or 360 day year. The days can matter because it can effect tax issues for some people, for example if you have to balance quarterly estimated payments with net income. It can also mean you miss the deduction on December interest for a full year. The OP is possibly in one of these special situations.

Bichon used to work in financial aid (I think he said that) so I'm inclined to think he knows what he is talking about. I also don't know how you could possibly get a deduction for interest you never actually paid or that was refunded on a returned loan.


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 Post subject: Re: Student Loan Interest vs. Principal
PostPosted: Tue Nov 06, 2012 5:45 pm 

Joined: Fri May 04, 2012 2:23 pm
Posts: 810
IMO, the OP would benefit from ensuring that they no longer have to take out any future loans opposed to worrying about saving $375 to $625 in taxes. Most likely, that money will be much more beneficial (from a financial stand point) making sure there are no more/minimal future loans. You can calculate this, but I have no idea what the terms of the loans are. Also complicating this is knowing how long one will take to pay off the loan(s). JMO.

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"If you only have 1 year to live, move to Penn...as it will seem like an eternity."


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 Post subject: Re: Student Loan Interest vs. Principal
PostPosted: Wed Nov 07, 2012 7:51 am 

Joined: Fri Feb 10, 2012 6:14 am
Posts: 48
I think it's a deduction, not a credit. So you'd "get back" 25% of it (or whatever your top tax rate is)


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 Post subject: Re: Student Loan Interest vs. Principal
PostPosted: Thu Nov 08, 2012 10:03 pm 
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Joined: Sun Jul 15, 2007 7:54 pm
Posts: 27
Location: Phoenix, AZ
ssarah wrote:
I think it's a deduction, not a credit. So you'd "get back" 25% of it (or whatever your top tax rate is)


Oof. You're right. I thought it was a credit. The fact that it's a deduction makes the benefit that much smaller. That makes my decision a little less complicated as I'm not getting a dollar-for-dollar credit. Since, as someone else stated, the interest isn't generally capitalized, I may not make that payment this year after all. The security of holding onto that money for the remainder of the year until I graduate might make me sleep better at night. Then once I'm back in the workforce, I'll drop everything I have on them at once and knock out a bunch of principal.

_________________
Car loan of approx. 5k at 0%.
Student loans of approx 60k that are going to be taken out quickly. Wedding comes first.


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 Post subject: Re: Student Loan Interest vs. Principal
PostPosted: Fri Nov 09, 2012 5:25 am 

Joined: Fri May 04, 2012 2:23 pm
Posts: 810
there will be a point when all interest will be capitalized to determine your payment amount. it is very important you knock that interest off the top before it becomes capitalized.

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Bichon Frise

"If you only have 1 year to live, move to Penn...as it will seem like an eternity."


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